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Cost-Volume-Profit Analysis

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  1. 8 Chapter Eight Cost-Volume-Profit Analysis

  2. The Break-Even Point The break-even point is the point in the volume of activity where the organization’s revenues and expenses are equal.

  3. Contribution-Margin Approach Consider the following information developed by the accountant at Curl, Inc.:

  4. Contribution-Margin Approach For each additional surf board sold, Curl generates $200 in contribution margin.

  5. Fixed expenses Unit contribution margin Break-even point (in units) = $80,000 $200 = 400 surf boards Contribution-Margin Approach

  6. 400 × $500 = $200,000 400 × $300 = $120,000 Contribution-Margin Approach Here is the proof!

  7. Fixed expense CM Ratio Break-even point(in sales dollars) = Contribution Margin Ratio Calculate the break-even point in sales dollars rather than units by using the contribution margin ratio. Contribution margin Sales = CM Ratio

  8. $80,000 40% $200,000 sales = Contribution Margin Ratio

  9. Unit sales price Sales volume in units Unit variable expense Sales volume in units × × ($500 × X) – ($300 × X) – $80,000 = $0 ($200X) – $80,000 = $0 Equation Approach Sales revenue – Variable expenses – Fixed expenses = Profit X = 400 surf boards

  10. Graphing Cost-Volume-Profit Relationships Viewing CVP relationships in a graph gives managers a perspective that can be obtained in no other way. Consider the following information for Curl, Inc.:

  11. Cost-Volume-Profit Graph Total sales Break-even point Profit area Total expenses Sales in Dollars Fixed expenses Loss area Units Sold

  12. Profit 1 2 3 4 5 6 7 8 Units sold (00s) Profit-Volume Graph Some managers like the profit-volume graph because it focuses on profits and volume. Profit area Loss area Break-even point

  13. Fixed expenses + Target profit Unit contribution margin Units sold to earn the target profit = $80,000 + $100,000 $200 = 900 surf boards Target Net Profit We can determine the number of surfboards that Curl must sell to earn a profit of $100,000 using the contribution margin approach.

  14. Equation Approach Sales revenue – Variable expenses – Fixed expenses = Profit ($500 × X) – ($300 × X) – $80,000 = $100,000 ($200X) = $180,000 X = 900 surf boards

  15. Applying CVP Analysis Safety Margin • The difference between budgeted sales revenue and break-even sales revenue. • The amount by which sales can drop before losses begin to be incurred.

  16. Safety Margin Curl, Inc. has a break-even point of $200,000. If actual sales are $250,000, the safety margin is $50,000 or 100 surf boards.

  17. Changes in Fixed Costs • Curl is currently selling 500 surf boards per month. • The owner believes that an increase of $10,000 in the monthly advertising budget, would increase bike sales to 540 units. • Should we authorize the requested increase in the advertising budget?

  18. 540 units × $500 per unit = $270,000 $80,000 + $10,000 advertising = $90,000 Changes in Fixed Costs

  19. Changes in Fixed Costs Sales will increase by $20,000, but net income decreased by $2,000.

  20. Changes in UnitContribution Margin Because of increases in cost of raw materials, Curl’s variable cost per unit has increased from $300 to $310 per surf board. With no change in selling price per unit, what will be the new break-even point? ($500 × X) – ($310 × X) – $80,000 = $0 X = 422 units (rounded)

  21. Fixed expenses Unit contribution margin Target net profit Given: Find: {required sales volume} Fixed expenses Unit contribution margin Expected sales volume Given: Find: {expected profit} Predicting Profit Given Expected Volume

  22. Predicting Profit GivenExpected Volume In the coming year, Curl’s owner expects to sell 525 surfboards. The unit contribution margin is expected to be $190, and fixed costs are expected to increase to $90,000. Total contribution - Fixed cost = Profit ($190 × 525) – $90,000 = X X = $99,750 – $90,000 X = $9,750 profit

  23. CVP Analysis with Multiple Products For a company with more than one product, sales mix is the relative combination in which a company’s products are sold. Different products have different selling prices, cost structures, and contribution margins. Let’s assume Curl sells surf boards and sail boards and see how we deal with break-even analysis.

  24. CVP Analysis with Multiple Products Curl provides us with the following information:

  25. CVP Analysis with Multiple Products Weighted-average unit contribution margin $200 × 62.5%

  26. CVP Analysis with Multiple Products Break-even point Break-even point Fixed expenses Weighted-average unit contribution margin = Break-even point $170,000 $331.25 = Break-even point 514 combined unit sales =

  27. CVP Analysis with Multiple Products Break-even point Break-even point 514 combined unit sales =

  28. Assumptions UnderlyingCVP Analysis • Selling price is constant throughout the entire relevant range. • Costs are linear over the relevant range. • In multi-product companies, the sales mix is constant. • In manufacturing firms, inventories do not change (units produced = units sold).

  29. Cost Structure and Operating Leverage • The cost structure of an organization is the relative proportion of its fixed and variable costs. • Operating leverage is . . . • the extent to which an organization uses fixed costs in its cost structure. • greatest in companies that have a high proportion of fixed costs in relation to variable costs.

  30. $100,000 $20,000 = 5 Measuring Operating Leverage Operating leverage factor Contribution margin Net income =

  31. Measuring Operating Leverage A measure of how a percentage change in sales will affect profits. If Curl increases its sales by 10%, what will be the percentage increase in net income?

  32. Break-even point Fixed costs Unit contribution margin = CVP Analysis, Activity-Based Costing, and Advanced Manufacturing Systems An activity-based costing system can provide a much more complete picture of cost-volume-profit relationships and thus provide better information to managers.

  33. A Move Toward JIT andFlexible Manufacturing Overhead costs like setup, inspection, and material handling are fixed with respect to sales volume, but they are not fixed with respect to other cost drivers.This is the fundamental distinction between a traditional CVP analysis and an activity-based costing CVP analysis.

  34. End of Chapter 8 We made it!